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With every investment option available, there are investments that are advantageous for some investors and others that are not necessarily a good fit. Fixed annuities are no exception to this sentiment. In this article, 5 financial experts break down the pros and cons of fixed annuities.
Most Fixed Annuities Are MYGAs, But Annuity Accounts Are More Designed For Retirees
“There are several advantages to fixed annuities. Most fixed annuities are (MYGAs) or Multi-Year Guaranteed Annuity Accounts. Owners know exactly what they are getting and what growth to expect now and in the future. For instance, a 5-year account that grows at a 4% rate each year is very easy to account for and understand. Assuming no deposits or withdraws, owners know to the penny what their account value will be every day and every year.
And fixed annuities can grow tax-deferred if desired. Owners are not required to withdraw funds and pay taxes. They can defer income taxes for the entire term of the annuity and then roll that growth (tax-free) into a
new annuity using a 1035 tax-free exchange. (Separate rules may apply if the annuity is an IRA and the client is 70 1/2 or older like they would on all IRA accounts.)
In many cases, annuities pay higher rates than similar fixed-income products offered from banks and/or mutual fund providers. And like bank accounts, annuities are insured up to $250,000 in most states.
Annuities also provide income flexibility. Most plans allow for systematic interest and principal withdrawals each year. These policies can be tailored in several ways to provide ongoing income now and in the future.
Owners can just take interest or draw down the principal depending on their needs.
There are some disadvantages, however. Annuity accounts are more designed for retirees. If you are under age 59 1/2 and withdraw interest from your account, you can be levied a 10% fine by the IRS. You need to make sure all withdraws are compliant with IRS rules when under age 65. And annuities have surrender penalties. These penalties can reduce your principal if you take more than your allowed amount during the annuity term. You don’t want to invest monies in annuities that might be needed in the immediate future.”
Adam M. Hyers, President, Hyers and Associates, Inc
Fixed Annuities Are Known For Having Two Main Benefits, But Are Not FDIC Insured
“Advantages- Fixed annuities are known for having two main benefits.
1) Tax-deferred growth. Tax-deferred growth allows your investment to compound at a quicker rate than if you paid the taxes annually. A common comparison to this is a traditional bank certificate of deposit, which forces the investor to pay the interest gains annually. Due to the tax-deferred status, the investor can reduce their annual taxable income which can be an important factor when dealing with high net worth investors.
2) Safe accumulation. Fixed annuities are best known for their principal protection. Similar to that of a bank certificate of deposit, the investor can rest assured they won’t lose any of their principal due to market fluctuations. The investor can reasonably expect to receive their principal, plus interest, without having the risk of losing the investment.
Fixed annuities can be a great investment for someone in or near retirement that is looking for an alternative to traditional conservative investment vehicles.
Disadvantages- Fixed annuities are backed by the paying ability of the insurance carrier. They are not FDIC insured like that of a traditional bank certificate of deposit, nor are they backed by the federal government like that of a bond. With fewer guarantees, the investor should expect a higher rate of return on a fixed annuity than that of a government bond or traditional bank certificate of deposit. Another disadvantage is that some fixed annuities restrict the liquidity of the investment. Meaning that some policies may allow a client to withdraw up to 10% of the investment, while others may not allow any withdraws for the length of the contract. If an investor were to withdraw an amount above what is allowed, or leave the fixed annuity before the contract is complete, the investor would be expected to pay a surrender penalty. This penalty can be near 10% of the investment and can be much steeper than the surrender penalty of other conservative investment options.
It is important the investor work with someone who is independent and a fiduciary, so they can compare a wide variety of fixed annuity options and would be legally obligated to offer what is in the investor’s best interest.”
Jordan Sester, Founder, J.S Financial Group
They Are Important Planning Tools For Spouses Of Nursing Home Residents
“Fixed immediate annuities can be important planning tools for spouses of nursing home residents. Under the Medicaid rules, couples must pay privately for an ill spouse’s care until their combined assets have been spent down to their home (if any) and a bit more than $125,000 in savings and investments. Often, the healthy spouse can preserve at least some of the benefit of the couple’s assets above this limit by using the excess assets to purchase an immediate annuity, in effect transforming an asset into an income stream. This works because there’s no limit on the healthy spouse’s income or requirement that she contribute her income to the ill spouse’s cost of care. Once the annuity is purchased, Medicaid will pick up the cost of caring for the ill spouse in the nursing home. One caveat is that the annuity must meet certain requirements, so it is always best to pursue this strategy with the assistance of an elder law attorney.”
Harry S. Margolis, Esq., Margolis & Bloom, LLP
Annuities Are A Great Way To Save For Retirement If You Do Not Mind The Fees Involved
“Annuities have the advantage of guaranteeing you constant income should you choose to be paid in a series of payment. These payments also allow you to choose the frequency of these payments whether they should be monthly, quarterly, semiannual or annual. There is also the option of a lump-sum. This comes in handy if you would love to set up a venture when you retire.
Annuities can be costly because of the many hidden charges that you may not notice at the time you signup.
Firstly, most of the annuities are sold by insurance brokers. We know too well that these people don’t work for free. So they do charge a commission for their work. If you’re subscribed to a variable annuity plan, it’s possible to receive less than what you contributed in your time as an employee. This value is pegged on the underlying assets. If they shift so does the value of the annuity.
Withdrawal penalties are also steep and you are going hurt the value of your annuity plan if you find yourself in a situation that forces you to withdraw from the plan.
Overall, annuities are a great way to save for retirement if you do not mind the fees involved and if you can find a way to go around them. This will involve looking for companies that shield you from insurance brokers and also if you can discipline yourself enough to ensure you do not make any unnecessary withdrawals.”
Edith Muthoni, Chief Editor, Leanbonds.com
Some Debate About The Use Of Fixed Annuities In IRAs
“There is some debate about the use of fixed annuities in IRAs. The negative is that since fixed annuities are already tax-deferred why would an investor wish to be redundant by placing a tax-deferred investment vehicle in an already tax-deferred account. However, some fixed annuities may provide higher interest rates than one could obtain by investing in a CD or money market.
The one argument that I would agree is using a portion of an IRA to invest in an equity-indexed annuity which technically is a fixed annuity but invests in an equity index with some restrictions. Essentially, an equity-indexed annuity invests in a stock market index but both the participation rate and cap rate are pre-determined. Thus the gain is limited if the various indices rise considerably but the return would still be greater than a fixed annuity that guarantees a certain interest rate. An investor in an equity-indexed annuity cannot lose principal but does not fully participate on the upside if the stock market index performs exceptionally well. An investor can thus protect the downside while possibly accruing interest greater than that provided by a traditional interest-bearing asset.”
Cliff Caplan, CFP(r), AIF(r), Neponset Valley Financial Partners
Fixed annuities are annuity contracts which have both benefits and drawbacks, depending on the individual investor’s needs. If you are interested in fixed annuities, take into account what the industry experts in the article have highlighted, and always remember before investing to do your due diligence.